Monday, June 29, 2009

We don’t read Paul Krugman much these days—not since the New York Times outsourced its newsroom to the White House press office—but we did catch his column, “Not Enough Audacity,” in which the Nobel Prize-winning economist frets that Obama’s health care efforts aren’t radical enough:

On one side there’s Barack the Policy Wonk, whose command of the issues — and ability to explain those issues in plain English — is a joy to behold.

But on the other side there’s Barack the Post-Partisan, who searches for common ground where none exists, and whose negotiations with himself lead to policies that are far too weak.

Now you’d think Obama’s masterful “command of issues” might have included the notion that the person nominated for Treasury Secretary should be a guy who paid his taxes on time. But leaving that aside, let’s look at the President’s “ability to explain those issues in plain English,” which skill leaves Krugman all weepy:

Mr. Obama offered a crystal-clear explanation of the case for health care reform, and especially of the case for a public option competing with private insurers. “If private insurers say that the marketplace provides the best quality health care, if they tell us that they’re offering a good deal,” he asked, “then why is it that the government, which they say can’t run anything, suddenly is going to drive them out of business? That’s not logical.”

This is very smooth, and it certainly seems “crystal-clear,” assuming you don't think about it for, oh, half a second.

But it is nothing like logical: Government has no profit motive. Private insurers do. So a government payer, even as badly run as it will be, will wreck the private insurers' business models.

Stock-market-wise, we couldn't care less how the health-care model gets resolved. In the investment business, you deal with facts as they are, not as how you wish them to be.

But we wonder: how did a Nobel Prize-winner like Krugman get fooled by a slick bit of rhetoric with no inherent basis in fact?

Well, the Times’ web site describes the economist thusly:

His professional reputation rests largely on work in international trade and finance; he is one of the founders of the "new trade theory," a major rethinking of the theory of international trade.

Let’s hope he’s not working on a major rethinking of the theory of human health care...

The content contained in this blog represents the opinions of Mr. Matthews.Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.

Okay, so we’ve been in a thankful mood recently (see “Thanks, Google” from June 15), and we’re going give thanks once more on these virtual pages.

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Not, however, to the Michael Jackson who married Elvis’ daughter, dangled his baby out a window, and re-jiggered his face into some sort of Dangers-of-Plastic-Surgery warning poster.

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The Michael Jackson who deserves thanking here is the genius who, when he was all of 23 years old, created a groove—the foundation of “Billie Jean”—that was as good as anything laid down on a record.

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That groove could put a crying baby to sleep—and in fact it did, many times.

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No matter how out of sorts she was, no matter how loud she was crying from that uncomfortable baby seat in the back of that tiny car, she stopped crying the second “Billy Jean” and its hypnotic base-line started to pulse.

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That crying baby is now a grown woman; Michael Jackson, dead and soon-to-be-buried—or whatever the hell his handlers decide to do.(Ashes buried on the moon?Body frozen alongside Ted Williams for a Second Coming? Corpse interred at a new Michael Jackson Morgue at Disneyland?)

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And although he was 50 when he died, way past the age of 27 when the likes of Kurt Cobain, Jimi Hendrix, Janis Joplin and Jim Morrison had all killed themselves in one way or another—Cobain with a shotgun, all doped up on heroin and Valium—the reality is Michael Jackson joined “that stupid club” a long time ago.

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But that’s how it seems to be for rock stars.

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Elvis was done by 27, even though he lived to 42.In fact he never made a song John Lennon thought worth listening to after he hit the big-time on the Ed Sullivan Show at 21.

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And Lennon’s first musical partner, Paul McCartney, wrote his last good song—“Maybe I’m Amazed”—when he was 27.

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It was McCartney, of course, who helped plant the seeds of Michael Jackson’s own musical demise when the pair collaborated on two songs that deserve their own special category—what the Brits call “Cringe-Making”—on any list of all-time Bad Rock Songs: “Say Say Say” and The Girl is Mine.”

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But we won’t remember Michael Jackson for his collaborations with a 40-year old ex-Beatle, or the tabloid stuff that came later.

We’ll remember him for a particular groove he created when he was 23 years old and the world was his.

The content contained in this blog represents the opinions of Mr. Matthews.

Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.This commentary in no way constitutes investment advice.It should never be relied on in making an investment decision, ever.Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to.This content is intended solely for the entertainment of the reader, and the author.

Friday, June 19, 2009

Lost Bragging Rights; Credit Default Squeeze Explained; Student Loan Business Unexplained; A Nephew Married and a Suspicion Confirmed; Charlie Munger, Rational to the Last; a Final Breakthrough Foretold

Lost Bragging Rights and a Mystery Explained

Warren Buffett loved his Triple-A credit rating.

He mentioned it frequently, and spoke of its importance as far back as his 2003 shareholder letter:

Among the giants, General Re, rated AAA across-the-board, is now in a class by itself in respect to its financial strength.

No attribute is more important…. When an insurer lays out money today in exchange for a reinsurer’s promise to pay a decade or two later, it’s dangerous – and possibly life-threatening – for the insurer to deal with any but the strongest reinsurer around.

In 2004 he crowed even louder about it:

Gen Re’s financial strength, unmatched among reinsurers even as we started 2003, further improved during the year. Many of the company’s competitors suffered credit downgrades last year, leaving Gen Re, and its sister operation at National Indemnity, as the only AAA-rated companies among the world’s major reinsurers.

So it is no big surprise when a shareholder at the Berkshire Hathaway 2009 shareholders meeting asks about the recent Moody’s downgrade of the Berkshire companies’ debt two levels, from AAA to Aa2, on “the severe decline in equity markets over the past year as well as the protracted economic recession.”

And it is no surprise at all when Buffett promptly admits that losing the Triple-A rating bugged him:

“I very much liked having a triple A. I was disappointed when Moody’s downgraded—we didn’t think that was gonna happen, but it did. It does cause us to lose some bragging rights.”

What is a surprise comes when, in the course of discussing the downgrade, Buffett reveals the answer to a mystery which prevailed for months prior to the meeting: what caused credit default swaps on Berkshire Hathaway—certainly nobody’s idea of a teetering financial institution on the brink of collapse—to soar to levels associated with companies more like Sears?

Turns out that, as we here at NMTU had ventured to guess (see “IsBuffett Worried? No, but Somebody Is,” from November 20, 2008), the spike had been caused by counterparties to the index put options Buffett had sold—prior to the market collapse—buying protection on Berkshire, driving the price of that protection up to absurd levels.

Here’s how Buffett explained it:

“When we write an equity put option—a billion dollar put—and somebody pays us $150 million, we get the cash and set up a liability. The other guy takes $150 million out of cash and sets up a $150 million receivable.

“Now, as the world has developed, the value of that asset has increased and he reports that through earnings, and we report that as a loss. BUT, we’ve got the cash, and he’s got an asset that’s due in 15 years or something.

“Now, his auditors say, you have to go buy a credit default swap [on Berkshire] to protect yourself against that receivable going bad…”

Hence the spike in credit default swaps on Berkshire Hathaway, which for a period of time made the Oracle of Omaha's 44-year-long accumulation of cash-generating businesses and insurance “float” appear to have no more going for it than Sears Holdings Corp.

Buffett concludes the discussion—by way of making his shareholders feel better about contracts that were, at that point, billions in the hole—with the observation that as the price of the credit default swaps increased, the cost to the counterparty of maintaining that put option soared.“It explains why people may want to modify their contracts with us,” he adds, smugly.

One Industry Not to Expect Warren Buffett to Buy Into

“The only thing out of bounds,” Buffett likes to say before the questions begin, “is what we’re doing now.” But that doesn’t stop shareholders and money managers from fishing.

Asked by a Montclair New Jersey shareholder to talk about the student loan industry—currently under a cloud given the recent near-death experience of Sallie Mae—Buffett lets Munger handle the question.

It turns out to be the briefest answer the entire day, and no doubt a disappointing one to the shareholder from Montclair:“We don’t know a lot about it,” Munger says. Period.

For Buffett and Munger not to know a lot about a business…well, that’s one business not to expect Buffett and Munger to buy into any time soon.

Suspicion Confirmed

The clocks in the Qwest Center arena are approaching 3 p.m.The crowd has thinned out, and the question and answer session is almost over.

The 51st and last question of the day now comes—oddly enough—from a young man with a microphone, standing in the audience near the front of the stage.

I say “oddly enough” because up until now, the meeting has been run entirely differently from years past.

Instead of shareholders asking questions unfettered from one of a dozen microphones placed around the Madison Square Garden-sized Qwest Center arena, Buffett chose three reporters—Carol Loomis of Fortune, Becky Quick of CNBC and Andrew Ross Sorkin of the New York Times—to ask questions submitted via email. In between each reporter’s turn, a shareholder chosen by lottery asked a question.This new format distinctly limited the kind of “What Would Warren Do?” questions that had come to dominate the proceedings, and made for a much more relevant set of questions.

It also, however, slowed things down.

After all, when a person stands at a microphone to ask a question of the world’s most successful investor and his equally intelligent (and highly acerbic) business partner, that person doesn’t want to look like an idiot in front of 30,000 people and a worldwide press corps.

Thus, in years past, the questions—though generally off-topic, and sometimes way off-topic—tended to be asked quickly, and to the point.

That same person, however, when emailing a question to one of the three reporters, may write to his or her heart’s content.

And that's why the questions from the reporters today—even the really good questions—have tended to be verbose and sometimes convoluted, none more so than the one about Berkshire’s derivatives exposure, which conjured up “Slim Pickens in 'Dr. Strangelove' riding a nuclear bomb” and much other flowery imagery to make a simple point—i.e. that Berkshire’s derivatives positions had cost a bunch of money, and what did Buffett think of that?

Furthermore, although Buffett himself started the meeting by highlighting the new format—“They’re all Berkshire Hathaway-related questions…. We had a problem where they drifted off the last couple of years: what we should do in school, that sort of thing”—he hasn’t exactly been forthcoming in responding to those Berkshire-related questions.

Buffett has refused to do a post-mortem on the General Re acquisition; failed to address a great question on the difference between the money-center banks that collapsed and one (Wells Fargo) that didn’t; professed ignorance of earnings management at one of the most earnings-managed companies in the world (GE); and dismissed the Index Fund-style 2008 performance of the four money-managers in the running to succeed him at Berkshire with a figurative wave of the hand (“They did not cover themselves in glory, but I did not cover myself in glory so I’m more tolerant,” he said blandly).

Indeed, one of Buffett’s favorite questions the entire day was entirely theoretical: What would Buffett have done had he been in the same position as Bank of America’s Ken Lewis, who felt pressured by Paulson and Bernanke to withhold making public the deterioration of Merrill Lynch during the financial crisis?

“Boy that’s a great question,” Buffett says enthusiastically, then turns the question on its head. “If I’d been in Ben Bernanke’s or Paulson’s situation would I do differently? We were in a fragile situation in September, if B of A had rejected Merrill on a material adverse change clause…. I’m gonna ask Charlie what he would do.”

Munger stirs in his seat and says simply:

“You can criticize the original decision to buy Merrill and the contract they signed, and that would be legitimate, but once they signed that contract I believe the Treasury and B of A behaved honorably”

With Buffett wondering out loud what he would do if he’d been Ben Bernanke or Hank Paulson, a suspicion—that he actually prefers answering the “What Would Warren Do?”-style questions to the strictly-business questions in which he might embarrass a member of the extended Berkshire family in front of 30,000 people—takes root.

And it is confirmed when the young man with the microphone standing in the audience asks the 51st question of the day.

The young man’s name is Alex, and he wants to know “how we can improve the economy.”

“We can do what the government wants us to do and spend, and housing formations are important. I don’t know if that gives you any ideas or not.” Buffett says suggestively.

The young man then turns to a young woman beside him: “Mimi, you’re my best friend, would you be my wife?”

It’s a set-up. The couple embraces, the audience applauds, and Buffett concludes the day’s question-and-answer session on a decidedly non-business note:

“I have two comments to make. Alex is my sister Doris’s grandson, my grand-nephew; and Mimi is terrific.”

The meeting is over. The crowd disburses.

Charlie Munger, Rational to the Last

If, by concluding the session with a grand-nephew's marriage proposal in front of 30,000 people, Warren Buffett appears to affirm the transformation of the Berkshire annual meeting into something more pep rally than business meeting, Charlie Munger has changed his own contribution to the proceedings not one bit.

In fact, Munger has added more to the proceedings than in recent years, although always in the same rich, deeply skeptical, highly moral vein that made him sentimental favorite of a good portion of Berkshire’s “quality shareholders.”

Asked how to improve the “financial literacy” of Americans, Munger says dourly,

“I don’t think you can teach people high finance who can’t use a credit card.”

When Buffett is asked whether he uses “a normal free cash flow over the discount rate” calculation in making investments and responds with his standard line—“If you need to use a computer or calculator to make the calculation, you shouldn’t buy it”—Munger adds:

“Some of the WORST business decisions I’ve ever seen is when people do these complex calculations. The worst I’ve ever seen was when Shell did that with Belridge Oil.”

(I still have the Lucite paper-weight with the tombstone ad announcing that deal from almost exactly 30 years ago. Merrill Lynch, my alma mater, helped do some of those “complex calculations” for Shell.)

And when Buffett defends his ownership of Moody’s—the ratings firm that contributed mightily to the subprime crisis by slapping Triple-A ratings on junk assets—Munger says:

“I think the ratings agencies eagerly sought stupid assumptions…it’s an example of being too smart for your own good.”

But Charlie Munger is no grumpy old man. He is, above all things, rational.

A discussion of recent stability in lower-priced housing markets, improved home affordability and the current high rate of absorption—Berkshire owns the second-largest real estate broker in the country, and Buffett notes that household creation is running nearly three times the current construction pace—brings this matter-of-fact observation from Munger:

“If I wanted to buy a house in Omaha, I’d buy a house tomorrow.”

Defending last year’s no-better-than-S&P 500 performance of the four investment managers in the running to succeed Buffett, Munger says:

“I don’t think we would WANT a manger that could think he could just go to cash on a macroeconomic basis and then jump back in…we can’t do it ourselves.”

Dismissing a question about last year’s decline in Berkshire’s stock price, Munger focuses on the future:

“What matters is this, our casualty business is probably the best in the world; our utility business, if there is better utility I don’t know it…and I could go down that list. And if you think it’s easy to get into that position Berkshire occupies, you’re living in a different world than I inhabit.”

Charlie Munger is, as always, thinking big thoughts.

And some that are more philosophical than have ever been expressed at a public shareholder meeting.

A Final Breakthrough

Asked about the potential returns from Berkshire Hathaway by a shareholder who notes that Berkshire’s book value has grown 20% only once since 1995, Buffett focuses on the numbers:

“It’s absolutely impossible that we’ll come close to a figure like 20%...we hope that we achieve a few percentage points better than the S&P 500 a year. If we get a couple points better—I’ll feel better.”

Munger, on the other hand, focuses on the intangibles:

“I think this company will make a big and constructive contribution to its surrounding civilization in the years to come.”

Asked if Berkshire’s “sustainable advantage is largely you,” and what happens to this advantage when he is gone, Buffett first jokes that this focus on his eventual demise is “Defeatism,” then argues the sustainable advantage is the culture “embedded” in the Berkshire businesses—a culture reinforced by this very meeting:

“Our culture, our managers, our shareholders JOINED that culture, it gets reinforced all the time, they see that it works… it’s meaningful because there will be people that want to join up with us and they won’t have a good second choice.”

Munger goes a step further:

“A lot of corporations in America are run stupidly from headquarters as they try and force the divisions to come up with profits every quarter that are better than the last quarter…and a lot of problems creep into that business.”

He finishes that profoundly insightful knife at the heart of American capitalism with a hint of his own brand of fatalism:

“While Warren and I will soon be gone…the stupidity of management in the corporate world will likely remain to give Berkshire a competitive advantage in the future.”

Yet it is when Buffett and Munger are asked about the potential for economic upheaval in these uncertain times that Munger comes through with the most remarkably philosophical answer to a question at any annual meeting:

“Well now that I’m so close to the edge of death,” he says matter-of-factly, “I find myself getting more cheery about the economic future. We are going to harness the direct energy of the sun...“What I see as a final breakthrough—you can see it coming over the horizon. I think it’s usually a mistake to think only about your probable misfortunes, it’s good to think about what’s good about our situation.”

The content contained in this blog represents the opinions of Mr. Matthews.Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.

Monday, June 15, 2009

Google’s ambitions—particularly in the book field, where it recently settled a lawsuit by publishers over its plans to scan every out-of-print book ever written so as to be searchable—have taken on Microsoftian overtones in the minds of authors, publishers and, now, Government lawyers.

The Justice Department has sent formal demands to Google Inc. and publishers for information about a deal that would allow the search giant to make millions of books available online, publishing company executives and people briefed on the matter said Tuesday.

The civil investigative demands, or CIDs, are the strongest sign yet that the Justice Department may seek to block or force a renegotiation of the settlement, which was struck last year and has not yet been approved in court....

Google began scanning books in 2004 so the text could be searched online, and publishers and authors sued to stop the effort in 2005, alleging it violated copyright laws. Google settled the dispute last year, agreeing to pay $125 million to settle claims, cover legal fees and establish a registry for publishers or authors to get paid when their titles are used online....

The settlement has drawn criticism from a variety of industry executives who say it will give Google broad copyright immunity and make it difficult for competitors to enter the market for digital titles. Google, the Authors Guild and major publishing companies have held the agreement up as a landmark case that will expand digital access to books.

—The Wall Street Journal, 06/10/09

As a former Google shareholder and an author who could not have written a book without using Google as the primary research and organizational tool (it took about a year to write “Pilgrimage to Warren Buffett’s Omaha,” including research, writing, re-writing and more re-writing, plus everything else that goes with publishing a book the old-fashioned way), I admit to a bias in Google's favor.

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But I strongly suspect the Google book-scanning deal will probably help authors in ways they can’t currently imagine.

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For starters, it will put content in front of people who otherwise would never know that content existed. Just consider one such book, “A History of the Yankee Division,” a 283 page history of the 26th Division of the 101st Infantry in World War One, recently made available thanks to Google.

The book, which was published in 1919, is long since out of print and concerns a relatively obscure matter: the start-to-finish account, from formation to armistice, of what was known as the “Yankee Division,” so-called because it was comprised of New England soldiers.

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But that division included my grandfather.

Now, until last week, all I knew about my grandfather’s two war experiences was that he had seen trench warfare in France during the First World War, and had traveled extensively through China as a military advisor to the government in its efforts to stave off the Japanese during the Second World War.

I understood that his time in France had involved real combat. (“Oh, you’d be standing in formation and the man next to you would get a bullet right here,” he once told me, pointing to his forehead. “That was every day stuff, that was.”) And I also knew he had a small, velvet-lined box of decorations which he didn’t talk about, even when pressed. “You wave a gun and some Germans surrender,” he’d say, “and they give you a medal.”

But that was about it.

And then Google scanned “A History of the Yankee Division” from the University of Michigan library, and made the book available to the world.

And now I know where my grandfather trained, where he landed in France, and where he marched, rested and fought. I know the ground he occupied on the day of the armistice, and even name of the ship that took him home.

Also, I also learned something about one of those medals he never talked much about :

First Lieutenant George L. Goodridge of the 101st Infantry, on November 8, with about thirty men, secured a footing in an advanced enemy trench. The attacking battalion met with stubborn resistance…. Goodridge and his men held on until relieved November 11. He received the Distinguished Service Cross.

What, exactly, causes a soldier to merit a “Distinguished Service Cross”? You can find that thanks to Google, too. According to Army regulations:

The act or acts of heroism must have been so notable and have involved risk of life so extraordinary as to set the individual apart from his or her comrades.

So, thank you, Google.

And let’s hope the so-called Justice Department doesn’t kill a great thing before everyone else can benefit, too.

The content contained in this blog represents the opinions of Mr. Matthews.Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.

Thursday, June 11, 2009

There is one more terrific question at the 2009 Berkshire Hathaway shareholders meeting—we’re jumping right into this without the usual two or three paragraphs of throat-clearing—that Warren Buffett failed to address.

It came from a Savannah, Georgia shareholder, and it followed up on Buffett’s earlier comment that on a cold November day in 2008, when news reached him that Wells Fargo was trading at $9 a share, he broke with his historical practice of not giving stock tips and told a group of students from the University of Chicago’s Booth School of Business that he’d put his “entire net worth” into Wells Fargo stock at that price.

“What about Fannie Mae, Citigroup, AIG?” asks the shareholder from Savannah, who rightly notes that a lot of people thought those stocks were buys-of-a-lifetime at $9 a share, and that not only did those stocks not rebound, they all went to a buck or less.Any investor who put his “entire net worth” into those stocks would have been wiped out.

Since many long-time “value” investors and Friends-of-Warren owned those stocks, it is a terrific opportunity for Buffett to describe how he looks at financials and managed to avoid those disasters, while sticking with Wells Fargo, one of the few major banks to make it through the crisis relatively intact.

But he does not.

“It’s what their business is and what their competitive model is,” Buffett says, offering no specifics. “…they each have different models but Wells is the most different.”

Then, without explaining how Wells is the most different, he launches into another mea culpa on his purchase of Irish banks.

“I was wrong on the Irish banks, I simply didn’t understand—and I should have understood-- the incredible exposure they had to land development loans. It was a terrible mistake, by me. I wasn’t paying attention.”

Having already flogged himself in his annual letter over the Irish bank debacle, Buffett is offering no new insight here. He then reverts back to question:

“There were a lot of signs that they”—meaning Citigroup and the rest—“were doing things that a highly leveraged institution shouldn’t be doing,” he says, without describing those signs. “You can get in a lot of trouble with leverage.”As if America hasn’t already figured that out.

One Self-Promoter, Put-Down

Professionals cannot resist advertising themselves at the Berkshire meeting.It happened each of the last two years, and veterans say it began in earnest when Buffett issued the lower-priced “B” shares. A lot of stock brokers began attending the meeting, fishing for rich clients.Despite the new format at this year’s meeting, it happens again, on the 18th question of the day, asked by a young from Illinois.

“If either of you were starting a fund today,” the young fund manager says, throwing out the name of his fund “hypothetically”—to which Buffett interrupts, “You’re gonna get billed for a commercial today,” to scattered laughter—“...would you sell stuff up 100% or hold long term?” the young promoter asks.

It’s a ridiculous question, and everyone in the room—except the young man from Illinois, maybe—knows it. Buffett has owned Washington Post from $6 a share, and didn’t sell even when the stock hit $999.50 on the last day of 2004, long after he had determined newspapers were a dying business.

But Buffett gamely answers anyway:

“We’d own them—our cost basis, except in rare cases, doesn’t have anything to do with it. When Charlie and I ran funds, we didn’t worry about whether something was up or down, we worried about what it was worth. We’d do the same thing 100 years from now.”

Munger, who suffers fools very unhappily, stirs briefly in his chair and says to the self-promoting Illini,“He’s tactfully suggesting you adopt another way of thinking.”

The laughter swells and the questions continue.

One Mystery, Answer Revealed!

In late February, 2009, a mysterious spike took place in credit default swaps on Berkshire Hathaway.This sudden rise in the cost of insuring against a default by Berkshire, heretofore unthinkable, made Berkshire, on paper, appear for a few days to be as risky a credit as Sears Holdings.

The irony was supreme, given that Sears happens to be the Berkshire-like investment vehicle for Sears Chairman and hedge fund ace Eddie Lampert, …without, of course, the good businesses, clean balance sheet, and 44 year track record of Berkshire and its Chairman and former hedge fund ace, Warren Buffett.

The credit default moves prompted reporters to scurry around, looking for clues as to why somebody, somewhere, seemed concerned that Warren Buffett’s “Fort Knox” might be vulnerable to the kind of liquidity crisis that had already taken down a good number of financial companies whose problems showed up in the credit market well before the stock market realized what was going on.

When asked about the recent downgrade of Berkshire's Triple-A credit rating, Buffett provided the answer to that mystery.We’ll examine that in our next, concluding chapter, along with:

One Industry Not to Expect Buffett to Buy Into, and the Most Philosophical Answer to Any Question, at Any Annual Meeting, Ever.

The content contained in this blog represents the opinions of Mr. Matthews.Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.

Monday, June 08, 2009

He’s on Fox Business News parsing the Friday unemployment numbers with Rebecca and the Happy Hour crew!

He’s in Success Magazine giving tips on, well, success!

He’s in the Salt Lake Tribune dissing corporate spin doctors!

The “He” is none other than Patrick Byrne—Doctor Patrick Byrne, we should say—the CEO of a public company called Overstock.com that recently reported a decline in first quarter revenues and a loss.

Now, declining revenues and net losses are nothing out of the ordinary in Corporate America these days—what the recession and all. Still, a tough environment should be right in Overstock.com’s wheelhouse, with plenty of “overstocked” merchandise looking for a home, and millions of downsized consumers looking for a deal.

Oddly enough, however, Overstock.com seems unable to take advantage of the same environment that is providing record sales and earnings for close-out or low-priced merchants such as Ross Stores and Family Dollar, not to mention Internet giants like Amazon.com.

Still, that isn’t stopping the company's voluble CEO from offering his opinions on everything from the better-than-expected unemployment report last Friday (Inflated by statistical adjustments, opined the Doctor) to the key to successful entrepreneurship (Are you sitting down? It is this: “find a need and fill it”).

As for corporate spin-doctoring, Byrne had this to say:

Overstock.com CEO Patrick Byrne suggests that rather than trying to influence the market through the timing of earnings releases, some companies use the content of their announcements to paint an overly positive picture of the results.

“They'll use all kinds of corporate pap to try and put a positive spin on their results,” he said. “They might talk about their pro-forma results and only later in the release reveal their actual results.”—Salt Lake Tribune, June 6, 2009

This from a CEO whose company that regularly reports “Adjusted EBITDA” along with “operating profit (loss)” and “net income (loss).” Possibly because, generally speaking, Adjusted EBITDA tends to be one of the few positive below-the-line numbers in the press release.

This from a CEO who once proclaimed that his company had “passed through the tipping point,” and thus “we can crush” expectations, and “we are really on a roll here.” Unfortunately that was early in 2005, which would turn out to be another money-losing year for Overstock.com (and 2006 would not turn out any better: Byrne would later call it “a wipe-out year”).

This from a CEO who once crowed that his company was “competitive with Blue Nile,” the well-run online engagement ring retailer, saying “we intend to dominate in the $1,000 to $5,000 range” of diamond engagement rings—something his company never came remotely close to doing.

And this from a CEO who, during that “wipe-out year” of 2006 explained an operating glitch as follows:

It's funny that you ask that. We actually have a truck full of important parts trucking in through -- coming in from L.A. through southern Utah, ran into a cow and tipped over the cab, and that actually, literally, has stopped the project for two weeks. But short of any more cows on the interstate, I don't see how that gets delayed. That's just bolting things together.

For “pap” and “positive spin,” it doesn’t get much better—or more worse, depending on your point of view—than that.

The content contained in this blog represents the opinions of Mr. Matthews.Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.

And that’s because whatever the “new economic data” might have been that “sapped investors’ recent optimism” yesterday, it had nothing to do with what’s happening in the real world.

What’s happening in the real world is this: the housing market is recovering, fast.

The following are yesterday morning’s comments from Hovnanian, the once-mighty home builder (280,000 houses delivered, and counting) in which we here at NMTU have no interest except to monitor what is happening in the real world, as opposed to on Wall Street trading desks.

Now let me get back to the sales trends we’re seeing in the market today. We have seen more then the typical seasonal uptick in sales throughout our second quarter. The seasonal aspect of the pickup in sales is not unusual but its noteworthy that this is the second consecutive quarter that our contracts per community were up year over year….

The contracts per community have shown a positive comparison for six of the past seven months and the comparison has been even stronger during the two most recent months with a 25% and 33% increase in net contracts per community for March and April respectively….

When you look at the MLS data for many markets today you see two positive forces at work. First you see absolute sales numbers have picked up and second you see inventory levels have come down. In some markets you could almost make the case that the month’s supply has corrected too much. Believe it or not, by normal standards there is actually a shortage of homes based on the current sales pace in certain markets including some of the markets that were the most over supplied not long ago.

Now, Mr. Hovnanian was quick to point out that part of the improvement has come from California, where a $10,000 state tax credit, on top of the federal first-time buyer credit of $8,000, has had a distinct impact. And of course, prices are down, which is why the market is clearing.

Finally, he was also quick to point out that rising rates could nip a recovery in the bud.

But interestingly enough, one of the fastest-improving markets was outside the Formerly Golden State, in one of the many markets once in contention for the label “Ground Zero of the Housing Bubble.”

The first reader who correctly identifies the market being described by Mr. Hovnanian wins nothing but recognition on these virtual pages:

At a five months’ supply this market looks a lot better than it did a year and a half ago when it had almost a 25 months’ supply.

It’s been a few years since the word “shortage” appeared in the same sentence as the word “homes,” at least in America.

The content contained in this blog represents the opinions of Mr. Matthews.Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.

Monday, June 01, 2009

Carol Loomis Goes Three-for-Three; No Post-Mortem on GenRe…or, How GenRe Outfoxed Warren Buffett; Perils That Lurk and the Four Managers Who Failed to Avoid Them.

Agonizing over errors is a mistake. But acknowledging and analyzing them can be useful, though that practice is rare in corporate boardrooms. There, Charlie and I have almost never witnessed a candid post-mortem of a failed decision, particularly one involving an acquisition. A notable exception to this never-look-back approach is that of The Washington Post Company, which unfailingly and objectively reviews its acquisitions three years after they are made. Elsewhere, triumphs are trumpeted, but dumb decisions either get no follow-up or are rationalized. —Warren E. Buffett

Warren Buffett wrote those words in the year 2000. He was describing for Berkshire shareholders about how a large advertising budget had failed to produce the desired growth at GEICO that year.

Fortune Editor Carol Loomis, Buffett’s editor for his annual shareholder letters and one of three reporters asking questions at the Berkshire annual meeting, recalled those very words when she asked, on behalf of a Berkshire shareholder, one of the best questions of the day:

“You’ve said management should do a post-mortem on acquisitions. Would you do a post-mortem on Gen Re?”

And although it was one of the best questions of the day, Buffett ducked it.

Now, the deal for General Re, for which Buffett paid what amounted to $16 billion worth of precious Berkshire stock on the closing date, was not a terrible one. After all, Berkshire got $16 billion in “float”—Gen Re's accumulated premiums available for investment—and a billion dollar annual earnings stream.

As things turned out, however, it was not a terrific one.

The terrorist attacks of 9/11 (or are we calling them “expressions of human rights” these days?) exposed a serious lapse in reinsurance underwriting standards at Gen Re that would wipe out more than $8 billion of retained earnings.

Furthermore, the Gen Re derivatives book gave Buffett and Munger less expensive but longer-lasting headaches, costing $400 million to unwind and leading Buffett to deliver his famous “ticking time bomb” early warning against the stuff five years before the explosion went off.

Of course, $400 million is a pittance and rounding error compared to the trillions in damages derivates did to the American economy. But to the rational mind of Warren Buffett—who paid for those derivates, along with the rest of Gen Re, in stock—that was $400 million worth of cherished Berkshire stock vaporized.

In fact, the cost was more than $400 million, since Berkshire stock rose in value over the years after the acquisition—by slightly more than half, at today’s price. Thus a $16 billion purchase price for Gen Re at the time of closing now stands at $25 billion, based on Berkshire’s Friday closing price.

On the plus side, Gen Re is these days an entrenched core of an insurance industry giant—what was, until recently, the only AAA-rated reinsurance business in America. It contributed $21 billion in float to Berkshire at the end of 2008, and although pre-tax earnings at Gen Re aren’t even half what they were back when Buffett acquired the business, he likes owning it.

Yet Buffett declined to perform any “post-mortem”—of the kind he once castigated most “corporate boardrooms” for failing to perform—for Berkshire shareholders:

“I don’t think you attract managers by pointing out the shortfalls that may have occurred with the managers that may be doing a very good job trying to overcome problems,” he said. “Gen Re has worked out after a terrible start.”

Instead of analyzing the largest and most important acquisition in Berkshire’s history, Buffett said what he wrote in his most recent shareholder letter: “Gen Re is now the company I thought it was when I bought it in 1998.”

Indeed, he seemed far more concerned with protecting the feelings of existing management at Gen Re in front of 17,000 shareholders sitting in the Qwest Center arena than rationally explaining the positives and negatives of the deal:

“It would really have been a mistake to discuss dumb decisions that might reflect on some of the managers of the businesses…”

Charlie Munger, on the other hand, presented a more frank appraisal of the deal:

“Joe was the steward for the General Re shareholders,” Munger said, referring to Joe Brandon, who was General Re’s chief financial officer for the decade before the Berkshire merger—presumably when the tainted derivates book was being built. “We got a decent result,” Munger said, referring to Berkshire shareholders, “and they got a fabulous result.”

“Post-mortem” avoided, Buffett moved on.

The best question of the day that Buffett did answer also happened to be asked by Carol Loomis—Loomis went three-for-three on the best questions—concerned the four investment managers Buffett has chosen to manage funds as a sort of test-drive to select one or more successors to Buffett.

“Can you please tell us, without naming names, how each of the four did in 2008,” Loomis asked. “How would you rate the way these four managers did in managing last year. Are they still on the list?”

This time Buffett answered the question, but it wasn’t what a shareholder might have expected to hear.

“I don’t have precise figures on all of them,” Buffett said. Now, this might sound odd given that most money managers know exactly how they’ve done every day, let alone for the year, at 4:01 p.m. Eastern Standard Time after the close of trading. But Buffett’s candidates reportedly include at least one insurance guy managing a complex portfolio.

In any event, while “all four are still on the list,” according to Buffett, they didn’t knock the cover off the ball in 2008:

“I would say they did no better than match the S&P, which was minus 37…so I would say in terms of 2008 you would not say that they did not cover themselves in glory.” Then, as he does, Buffett disarmed the audience with a self-critical disclaimer: “But I did not cover myself in glory so I’m more tolerant.”

This generated laughter and a light-hearted follow-up from Munger:

“Every investment manager that I know of in America that is intelligent…they ALL got creamed last year.”

This generated more laughter—despite the fact that getting “creamed” in a financial crisis was probably not exactly what Buffett had in mind when he selected his money managers:

Over time, markets will do extraordinary, even bizarre, things. A single, big mistake could wipe out a long string of successes. We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions.—Warren E. Buffett

Buffett himself read those very words, first written in the his 2006 letter to shareholders, to this same audience two years ago, wishing to emphasize the importance of preserving Berkshire’s capital in the face of unimaginable—by most—dangers, far into the future.

And yet the four managers competing for the job of replacing “The Oracle of Omaha” apparently failed to do just that.

It is the least satisfying, and most unnerving, answer of the day.

We wind up later this week with:

· Sharpest Implied Put-Down· Mystery Revealed!· One Industry Not to Expect Buffett to Buy Into

And

· The Most Philosophical Start to Any Answer at Any Annual Meeting in History, Since the Beginning of Recorded Time

And then back to business and anything else that strikes our fancy—including The Postman Who Freaked and other matters.

The content contained in this blog represents the opinions of Mr. Matthews.Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.